Nykaa: Beauty-ful E-commerce play

Company Name – FSN E-Commerce Ventures Ltd (Nykaa)

Current Share Price – INR 147 (August 7, 2023)

Market Cap – INR 41,920 cr

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1. What is interesting about the stock?

“Makeup is not a mask that covers up your beauty; it’s a weapon that helps you express who you are from the inside”.

— Michelle Phan

How much time does your wife or female partner take to get ready? Always, beating the expectations!

Looking good is a basic need of any human being – it is a bit more pronounced in the fairer sex for a lot of cultural or psychological reasons. Beauty, personal care, and fashion products are an age-old industry that would also be evergreen. We may shift from offline to online or from chemical-based to natural/vegan etc but the need would always be there.

Fashion is easy to understand. But, what is covered in beauty and personal care products is the face, body, eye, lip, and nail products.

Based on my personal experience, the amount of beauty, personal care, and fashion products purchased (per capita) in India is significantly less than in the Middle East or South East Asia. Even Europe and US are ahead of India. The current per capita expenses on the beauty & personal care (BPC) market in India are estimated to be around USD 15 which is expected to increase to USD 50 in the next 8 years. The expected growth rate could be around ~15% for the next few years driven by under-usage (vs global standards) and an increase in disposable income. Online penetration in the BPC industry is around ~17%. China, the US, and Korea have online penetration of 35%, 20%, and 45% respectively. A lot of room for online BPC industry growth.

Enter Nykaa!!

Nykaa is a consumer technology platform selling beauty, personal care, and fashion products. The Company was launched in 2012 to focus on the BPC segment and is an omnichannel player with around 154 physical stores across 60 cities. Beauty products have very high margins which makes them vulnerable to fake products. So, Nykaa follows the inventory model to solve the authenticity issue in the BPC products. BPC contributes to around 87% of the Company’s revenue. The Company launched the fashion segment around five years back.

Competitive intensity has increased over the last 1-2 years. Horizontal players like Amazon and Flipkart are increasing their focus on the segment. VCs have pumped a lot of capital into the competitors like Purplle and Good Glamm group after seeing the Company’s IPO success. Other players like Reliance and Tata Digital, with deep pockets, have also entered the space.

Investors are concerned about corporate governance standards at the Company. The pre-IPO investors' lock-in period ended on November 10, 2022, and the Company announced a bonus issue with a record date of November 11. Some investors believe this was a tactic by management to prevent them from selling their holdings. The bonus shares may not be immediately available, and the taxation structure may disincentivize some investors from selling.

Why invest in Nykaa?

• The key investment arguments summarized would be:

• Market leader in the online BPC space which is expected to grow fast

• Content-led business model with a focus on curation – influencers and ~ 15 million followers on social media

• Extensive (and sometimes exclusive) brand relationships

• Excellent management team

• Profitable start-up (especially at EBITDA level)

How do operating metrics look?

We need to understand and focus on operating metrics when investing in a young start-up. The company generates 87% of its revenue from the BPC segment so I would focus on its operating metrics:

Key takeaways:

• Unique transacting customers have grown from 3.5 million in FY19 to 10 million in FY23 – ~3x increase but the growth has slowed in FY23

• Average order per customer has gone up from 3x in FY21 to 3.5x in FY23

• Average order value had sharply increased in the COVID period – is slightly down in last couple of years

• Contribution margin per order has increased in last three years but as we would see in the detailed financials – the employee cost has increased at a faster pace so the benefit is not flowing in the bottom line

2. Key Historical Financials

• Company revenue has grown at a CAGR of 55% in the last 5 years

• However, the EBITDA margin has been ~5% even with increasing revenue – no sign of operating leverage

• As a matter of worry, the Cash flow from Operations (CFO) has been negative for FY22 and FY23

• ROCE and ROE peaked in FY21 when Company came for the IPO and is on a declining trend

3. What is my view on company valuation?

The stock price of the Company has more than halved from the IPO listing price in November 2021. Market has punished for poor corporate governance and increase in competition.

Company trades at Price to Revenue (FY23) ratio of 8x in comparison to:

• International peers like Ulta trade at a multiple of Price Revenue ratio of ~2x

• VCs have invested in the Company’s competitors like Purplle and Good Glamm Group at an equity valuation of around 8x revenue. We should keep in mind that VCs invest in a company with a lot of downside protection – with clauses like liquidation preference (if the company is sold then the money is distributed based on waterfall where the last investor get 1-2x of the investment first before any previous investor receives any money) and valuation reset in a down-round (if the company value reduces, the investor in last round get its valuation reset to the new lower number). So, we should apply a discount to any VC investment valuation as the public investor does not get the same downside protection

On an overall basis, current business is strong but the Company is overvalued at the current levels by any metric.

4. What are the risks to the investment analysis?

Risks to the analysis are:

• Lack of profitable alternatives in start-up space can keep retail investors interested in the short/medium term

• Company could be a good acquisition target

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About the Author

I have over 17 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.

I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).

I am an Insignificant Investor in the public market and co-founder of SocInvest.

Disclosure

I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.

I am not a SEBI registered advisor. This article is purely for educational purposes and not to be construed as investment advice. Please consult your financial advisor before acting on it.

I have used publicly available information while writing this article.